Oh look, a meme!

Seeing that I have not done stupid things in a while, I might as well fulfil my monthly quota (the smoke incident was not stupid; it was tragic). Here is a meme pinched from ze godsister:



Do you consider yourself weird or crazy?
Weird.

Who do you think the teddy bear was named after?
A long time ago I read in a general knowledge books for young children that it was Theodore Roosevelt. There’s a story behind it, something about a bear.

Do you like mint?
Generally ok.
However, I have seen mint things that most people cannot imagine (no, I’m sure you can easily imagine a mint flavoured condom). In this instance, it was a mint flavoured pau (the white steamed buns typically filled with char siew, red bean or kaya). The sweet, warm, menthol-laden and cooling paste came as quite a shock, seeing I was not expecting mint in my pau.

Are you sexually confused?
Despite being accused of that now and then, I am not sexually confused. When I was working at the restaurant, I had the extreme misfortune of having a gay man ask me if I can be dessert. Horrors. If it was a woman I could have at least flirted back or something.

Are you claustrophobic?
Only when I’m feeling restless on long flights when I am already tired, unwell and then stuffed into a non-aisle seat.

Are you afraid of heights?
No.

Do you think you sing well?
No, and I’m certain of it. I feel exceedingly out of place in karaoke sessions – the fact that I don’t really pay attention to songs make me not know a whole lot of them.
Do you know this song? No. What about this, surely you’ve heard it before? Er.. no. Ok, this one then? No.
Ultimately it frustrates the shit out of whoever who’s trying to be helpful, and I end up paying to watch people sing.

Do you like anyone?
Yah I like Jean!! <3

Do you think branded things are over-rated?
Sometimes, it’s comforting to know that the plane you are travelling in is an Airbus instead of a Fokker.
Also, the difference between a BMW and a Proton shouldn’t be neglected.

Do you think you're likely to get dementia at old age?
Does not seem likely, if my grandparents are any indication.

Do you cross dress?
Yes. I have a rather splendid collection of blouses, pleated skirts, evening gowns, knickers, A-cup bras, a few nylon stockings (these used to be really rare during the 2nd World War because parachutes were supposedly more important than stockings) and patent leather heels.
However, I have some rather masculine clothing so I’m not totally whacked. I’m particularly fond of my collection of studded leather underwear.

Are you into magazines?
I used to be, when I had to take a 45-minute train ride to that silly institution masquerading as a school. Back then we had a shit load of magazine subscriptions at home – National Geographic, Far Eastern Economic Review, Reader’s Digest, Time, Asiaweek, Discover, Scientific America, The Planetary Review.
The fees must have amounted to a bomb, but those 2 years of reading gave me so much knowledge that in hind sight, that silly institution might have been good for me after all (only because it forced me into sitting in a train for 1.5 hours a day).

Do you read a lot?
I used to. When I had access to the university’s library I would dig up books from the medicine, mathematics, physics and economics library for kicks.
Now I just work, study and waste time.

Are you an atheist?
No, I’m somewhere between a Buddhist, Taoist and agnostic.

Are you hard headed?
No, in fact my skull is so soft you could press it with the back of the spoon and it’d yield, allowing you to manipulate (or even scoop out) the contents. Inside, you’d mostly find air and differential equations.

Are you into movies?
No.

Do you like the TV?
I used to dislike it. Now I just don’t give it a damn.

Do you like the computer?
It’s my only way to connect with the world. No TV, no movies, no newspapers…

Are you fond of cosplaying?
Only if the hot girls wear teasingly short skirts with tight blouses. And if the guys stay out of sight.
But really, that situation need not be restricted to cosplay alone.
And I cannot relate to cosplay, so I will simply say I am not fond of cosplay.

Do you hate rap?
I just hate listening to it.

Do you wear polka-dotted undies?
Oh yea! Forgot to mention my polka-dotted undies earlier. A matching set of panties and bra.

Are you interested in politics?
Not really.

Are you a man of many words or are you a man of a few words?
Few words. Very few words.

Are you good at small talk?
As suggested above, no. I’m terrible at small talk.

Will you grow up to be a fine man?
I’m already grown up, a man. Cannot attest to my fineness.

How do you feel after completing this dumbass survey?
Like the dumbass I am. I just wasted a bunch of time that could have been used for studying. And the exam is next Sunday.
Dumbass indeed.

Deprivation

The author is deprived of many pleasures including, but not limited to:

gelati
cafe latte
rich, fishy laksa lemak
buttery kaya toast

He is also deprived of many joys including, including but not limited to:

noisy dinner parties with his family and relatives
quiet dinners with the girlfriend

Of course, there are a handful of other perverse desires that should not be publicly aired, such as:

driving a small BMW through fast, curvy mountains roads
wielding an obscenely sharp blade against a helpless chunk of pork

Several days ago, I thought I had reverse engineered a fantastic technique for making fried rice. It was brilliant; who knew plain fried rice with egg, garlic and a pinch of szechuan pepper would be so good.

Later, I saw that the szechuan pepper powder contained the following: szechuan pepper, salt, MSG.

Shit, MSG.

Today, I repeated the recipe, omitting the sinister szechuan pepper powder. The rice turned out as expected, but without that mind-blowing edge. The technique works, but it’s not a silver bullet, one-shot-kill kind of trump card.

Oh shit, is that smoke?

I came back from a trip to the supermarket AND wet market loaded with one week’s supply of essential foodstuff such as vegetables, rice, pork, potato crisps and coconut juice*.

As I approached my apartment, I noted an odd smell.


--flashback--
It was nearly noon, and if I did not leave soon I’ll not be able to get back by 1 pm. The cleaning lady was due to arrive at 1, and I did not want to make her wait.

I turned up the flame on my duck soup to get it boiling sooner, and went to brush my teeth. Teeth brushed to perfection, wriggled into my jacket, I picked up the bag of rubbish and stormed out of the house.

--end flashback--

When I linked the odd smell to the smell of burning stuff, my brain switched into a panicked loop. “Not my stove not my stove not my stove not my stove not my stove not my stove not my stove […],” it chanted to no one in particular. The trance-like chanting took up much of my mental resources, leaving little processing power for my motor control. I had to fumble with the key about for a while before getting the door opened, and was greeted with a dense white haze filling the upper half of the apartment. The haze was so dense that it was impossible to see more than 2 metres ahead.

I rush to the kitchen to find a blackened pot over a furiously burning gas flame, white smoke issuing out of the lid’s little vent. Whatever water in the pot had been boiled dry long ago, and the smoke jetting out of the pot (and subsequently filling the entire apartment with layers of haze) was vaporised duck fat and protein.

The windows and balcony doors were thrown open to ventilate the place, and within a minute I could actually see from one end of the apartment to the other. My adventure, however, was not over.

From upstairs, I heard someone shouting. Shortly after, there was a frantic banging on my door. I found a man asking if everything was ok- he detected a strong burning smell from upstairs and came to see if there was anything wrong. I had to explain it was a kitchen incident; all is fine and thank you so much for your concern. He asked again if everything is ok (to which I said it’s fine) before turning to go.

Several minutes later, the doorbell rang. This time, it was a guard. Someone had called the building management about a strong smoky smell, and he was tracking down the source. He had checked all units from level 17 till he reached mine (there are 3 units per level, I live on level 10). Again, I explained that it was a kitchen incident and it’s under control.

A thoroughly unpleasant experience it was.



* coconut juice is one of the most fantastic drinks I’ve seen recently. Unlike coconut water which is a light, clear liquid, this coconut juice is diluted and sweetened coconut milk. It’s rich, fattening and comes with a flavourful punch. A very soothing drink, perfectly suited to calming the nerves after a smoky scare.

Option valuation- understanding how price volatility and duration to expiry affects the value of an option

This rather long article is laid out as follows:

Summary
Option fundamentals
Valuation approach
Relationship between profit from an option and the asset’s market price
The probable market price at exercise date of the option
How likely is it that I will profit from this option?
How much profit can I expect from this option?
Another example: on the money option
Volatility sensitivity of options
Valuing the option: a hand-waving approach

Summary:
The price volatility and duration affects options because of the asymmetrical way options payback the holder. High volatility implies a high likelihood for prices to move either up or down. If process move in one direction, the bond holder gains. If prices move in the opposite direction, the option holder does not suffer losses.
Thus, a larger price volatility and longer duration give will almost result in an increase in the value of the option.


Option fundamentals
Options are securities that grant the option holder the right to buy or sell an asset at a predetermined price some time in the future.

An example of an option to buy (a call option) would be an option to buy 100 barrels of crude oil for the price of US$ 7500 in December. The agreed upon price is called the strike price.
If in December, the market price for 100 barrels of crude oil increased to US$8000, the option holder will decide to exercise the option’s right to buy from the option writer at the cheaper price. Thus, the option holder’s profit is US$ 500.
However, if the price instead decreased to US$ 7000, the option holder will be better off buying in the market. So the option will not be exercised, and the option holder does not profit.

Therefore, the call option allows the holder to profit if the asset price increases, but does not result in losses if the asset price decreases. Of course, there is no free lunch; the option has to be purchased at a cost. We will discuss how the price volatility affects the cost of an option.


Valuation approach
The approach taken here is the estimate the expected return from the option position, then discount the value for risk.


Relationship between profit from an option and the asset’s market price

Returning to the above example, we can see that if the asset price is below the strike price, the call option holder does not suffer any losses. But if the asset price is above the strike price, the option holder can buy the asset at the strike price, and then sell the asset in the market at the market price, thus profiting from the difference between market and strike prices.

Figure 1 below shows the relationship between ending price and profit. Notice that if the ending market price is less than the strike price, there are no profit/losses. When ending market price is above the strike price, the profit is the difference between the strike price and the market price.


Figure 1


The probable market price at exercise date of the option

While we may be able to predict certain trends in the market, there will always remain a large element of uncertainty. Likewise, there is an uncertainty regarding the market price of the underlying asset at the expiry of the option. Two factors affect the uncertainty of market price at expiry date: duration to expiry, and volatility of the price.

If the option is to expire next week, and the market price today for 100 barrels of crude oil is US$ 7750, we would expect the price next week to be close to US$ 7750. The probability of a large change is small (but still present: a severe industrial accident in a major refinery could push prices up abruptly).

However, if the option is expiring in 6 months, there is more time for all sorts of market events to cause changes for the price of 100 barrels of oil to move away from the current price of US$ 7750.

In figure 2 below, we illustrate the probability of ending prices. As the graphs show, prices further in the future are more likely to move further from the current price.



Figure 2

The effect of price volatility is similar: assets which are more prone to fluctuation will have a more spread out probability density function than assets which have more stable prices.


How likely is it that I will profit from this option?

Earlier, we have shown that the profit from a call option position is asymmetrical: the holder profits if the asset price is above the strike price, but does not lose if the asset price is below the strike price.

Let’s say the current asset price is 7750, and the strike price is set at 7500. We have two options, one that expires in one week, and one that expires in 6 months. If we were able to exercise NOW, we would definitely gain 250 in profits. But what about 1 week or 6 months later?

Figure 3 below shows that for the one-week option, we will almost certainly be in a profitable position. However, there is a chance of not being profitable if we take the 6-month option. This is because the longer duration increases the likelihood of the asset price moving below the strike price (however, we must not forget that the asset price can also move up higher).




Figure 3


Of course, this is not the end of our analysis. While we can now estimate the likelihood of making a profit, we still need to have a feel of how much we can expect to profit.


How much profit can I expect from this option?

If we are interested in estimating the expected profit from an option position, we need to find the total of the (probability of a particular asset price × the profit at that asset price) for all possible asset prices.

The expected profit from this position is the area below the (probability of a particular asset price × the profit at that asset price) curve. For the position of options expiring in 1 week and 6 months, the calculations are displayed graphically below (these calculations cannot be solved geometrically in a practical manner; a spreadsheet was required to calculate the probability density function, multiply the probability with the profit, and then calculated the area).



Figure 4


Figure 5

If we compare expected profit and likelihood of profit, we see that the 6 months position has a small likelihood of not profiting (as shown in figure 3) but greater expected profit. This is due to the fact that the 6 month option can earn large profits if the underlying price moves upwards significantly, but make no losses if the price goes below the strike price.


Another example: on the money option

The sensitivity of an option’s value to price volatility and duration is particularly severe for an on the money option. This is an option which has a strike price equal to the current underlying price. We use the same examples as above, but this time the strike price is the same as the current price. If prices move up the slightest bit, the option holder will profit, but if prices move down the slightest bit, option holders will not lose money.



Figure 6



Figure 7


Volotility sensitivity of options

If we were to compare the sensitivity of options, we can see that an on the money option is very sensitive to a change in volatility (in the examples in figures 6 and 7, the expected profit jumps from 52.08 to 102.71, a 97% leap) while an in the money option is less sensitive (in the examples in figures 4 and 5, the expected profit jumps from 373.05 to 381.04, a mere 2% incement).

If an option was deeply out of the money (the strike price is well below the current underlying price), then we expect the option to expire without turning us any profit. Unless we have a massive increase in volatility, the value of this option will be very close to zero regardless of volatility.


Valuing the option
If the option holder is completely indifferent to risk, then the option holder will be willing to pay the expected value of the option in order to own the option.

However, this does not apply in the real world: buyers want to be reimbursed for risk. Thus, buyers will not be willing to pay the full expected value for an option with uncertain returns.

For options that are deeply in or out of the money, the option price will be very close to the expected profit. For in deeply in the money options, the expected profit is equal to the difference between the strike price and current market price (this is also equal to the area under the probability × profit curve). For deeply out of the money options, the expected profit is zero.

For options that have their probability functions straddling the strike price, the option price has to be adjusted for that fact that there could be decent profits or none at all. For volatile or long duration options (figure 7), we will expect the discount to be substantial; for less volatile and shorted duration options (figure 6), the discount will be less.

A peep

I’m alive, barely.

The week started on a horrific note on Sunday when I the nuclear bomb I had been unwittingly nurturing hit puberty. All this while I thought I was planting sweet potatoes, when in fact I had been feeding the said bomb with more and more fissile material.

The resulting boom killed the last of the giant pandas, and I’m now harbouring a deep sorrow and guilt. The pain, horror and guilt of knowing that I had harmed something so harmless and completely lovable felt like a vibrating, barbed stake plunged into my cranium and left to do its damage. It has made me nearly cry myself to sleep every night since.

Sorry pandas! ^^




On a more positive note, I’m now in Shanghai.

After the prolonged stint in frumpy Tianjin with its dust encrusted low-rise flats (decorated with a sprinkling of architecturally fugly high rise commercial buildings), the endless fields of skyscrapers in Shanghai was a welcoming sight. Along with the incessant honking of cars and endless masses of people everywhere, the food has been promising so far.

Today I had to stay late at the office so I dug around at the receptionist’s desk for some home office-delivery menus. Ordered a pork belly rice and a wintermelon soup at 6 RMB each (equivalent to 3.11 MYR or 0.88 USD or 1.32 AUD or 1.30 SGD).

For 6 RMB, the rice was great. 2 large strips of pork, 3 small servings of vegetables and rice. The soup was equally brilliant: it came in a paper tub (it’s like a paper cup but with different dimensions and more robustly constructed, fitted with a plastic cover) and amounted to a significant volume. Remarkably, there was a fair bit of wintermelon and meaty chunks of pork ribs- they had actually throw in the good stuff till it’s reasonably full, then filled up the gaps with soup.



Oh talking about currencies, the value of the Australian Dollar fell terribly. From 3.00 MYR to the AUD, it took a plunge to ~2.3. I’m not amused – my only Visa card (and that’s merely a Visa Debit) was issued in Australia, and all Paypal transactions have been paid out using AUD. The plunge meant I would need to fork out more AUD for the same amount of Euros/ SGD/ USD. Bugger.

Best I find myself another credit card issued in another currency. The option would allow me to buy using the best available currency.

Trying to be an optimist, I suppose the good thing about seeing wild swings in the economy is to instil some sensibility in me. Just so I know not to rush into anything guns blazing and position unhedged.



Shit it’s already 2 am. Will finish up my work and leave the office. Toodles!